We enter week two of the government shutdown with seemingly little progress in resolving either the budget or debt ceiling impasse. We will say that we are somewhat encouraged that both of these issues have been put on the same track, forcing politicians to deal with the debt ceiling rather than holding it hostage as a separate leverage tool. It also seems that the conversation is morphing from the more immovable Obamacare discussion to general spending levels, which we think provides more points to compromise. Having said that, default rhetoric also continues and, while we still think that we will not (and really should not) get past the X-date, we have spent the better part of this report reviewing possible default scenarios. It is worth noting that the government will continue to collect sizeable revenues that could easily cover debt service. However, after the X-date, when expenses outstrip revenues, some obligations would have to be delayed if all debt service is paid. Treasury and the Administration continue to contend that October 17 is the X-date, although we suspect that there is slight play in that date. The market for short bills is the only asset class that has seen a significant increase in volatility, although equities have shown more weakness recently. At this point, we think that many investors have taken a ‘wait and see’ attitude, having made their hedges and bets positions prior to the shutdown. We don’t, however, think that risk premia reflects a default and think a conservative stance is warranted given the unknown and binary nature of the shutdown. Janet Yellen will apparently (and finally) get the White House’s seal of approval, although we still think the Fed would lean towards a December taper if possible. Data releases have been spotty since the shutdown, and will need to be taken with a grain of salt the longer the shutdown continues. For instance, the two employment reports that were released just after the 1995/1996 shutdown had very large revisions, likely due to survey integrity issues. We still put the odds of a default low, but have needed to increase those odds recently given the slow or non-existent progress in Washington. Unless we get a monetary default, we don’t expect Moody’s or S&P to take any preemptive ratings actions, although Fitch has threatened to downgrade U.S. debt if we reach the X-date without an agreement. Read the full commentary now.
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